The currency markets stuck to their established pattern on Thursday with the dollar pushing up versus the majority of the majors. As you have undoubtedly heard by now, Japan was rocked with an 8.9 magnitude earthquake and slammed by a tsunami shortly after. This is the news that is dominating the markets, so I will break from my usual pattern of talking about the US first, and instead, begin in the west and work my way east.

The earthquake, which shook Northern Japan during their afternoon was the worst quake to hit Japan in over 300 years. The quake generated a Tsunami that slammed into the northeast coast of Japan causing additional damage. Surprisingly, the Japanese yen (JPY) rallied after the quake. This seems to be counter to what you would expect, as you would expect any catastrophic event to have a negative impact on the victims’ currency. The quake that hit Christchurch, New Zealand is a good example, as the kiwi (NZD) has been sinking ever since it hit. But the Japanese yen rallied. After digging a bit, I uncovered what seems to be the reason. Japanese investors are big savers, but rates in Japan have been near zero for over a decade. These Japanese investors have invested their savings into foreign markets, including the higher yielding currencies of New Zealand and Australia (AUD). But this natural disaster has caused these Japanese investors to bring their currency back home, as they fear they will need it to help rebuild. And this repatriation of funds has been even more pronounced for Japanese companies who are moving their reserves back into their home currency.

So this would account for the knee-jerk reaction to the disaster. But the question is what happens to the Japanese yen over the longer term? Will the yen maintain its strength, or sill it slide like the kiwi? Japan’s Prime Minister has mobilized Japan’s self defense forces (they still have to call them that after losing WWII) and the central bank has pledged to ensure financial stability. The government seems to have calmed the markets for now, but faces a tough choice in the future. The BOJ has been struggling to bring down its budget deficits, but the rebuilding in the aftermath of the quake and tsunami will certainly lead to more deficit spending. The economy will actually benefit from this disaster in the short run as there will be fiscal stimulus from reconstruction. But Japan’s budget deficits are already close to 10% of GDP, and this additional spending will only add to the problem facing Japan’s aging population. While the yen may benefit in the short run, I wouldn’t suggest it for longer term investors.

One Asian currency that I would suggest is the Singapore dollar (SGD). As we have explained to investors in previous Pfennigs, the Singapore Monetary Authority uses the value of their currency as their main monetary tool to combat inflation. So while most central banks are trying to find ways to devalue their currency, Singapore’s is actually letting theirs appreciate. The Monetary Authority of Singapore will be meeting again in April, and with inflation heating up throughout Asia, a boost to the Singapore dollar is expected. The central bank is expected to try and cool their inflation by strengthening the Singapore dollar according to 11 of 13 economists polled by Bloomberg. And Singapore has some very good economic fundamentals in addition to their aggressive central bank. So for investors looking to diversify into Asian currencies, Singapore seems like a logical choice!

China’s inflation and industrial production exceeded forecasts in February. Consumer prices rose at an annual 4.9% rate in February, and industrial output increased 14% during the first two months of 2011. This data will put more pressure on China’s central bank to try and cool their economy. These reports indicate that their attempts so far have not been enough to hold off additional price increases. China, unlike Singapore, uses interest rates and reserve requirements to attempt to control inflation. Officials in the US would like to see China copy Singapore and allow their currency to appreciate in order to combat price pressures. But People’s Bank of ChinaGovernor Zhou Xiaochuan said today that interest rates will be used to curb inflation, and played down the role of currency gains. “Interest rate adjustment should not only focus on consumer-price inflation,” Zhou said today at a briefing in Beijing. “It has many other policy targets.” Zhou apparently is comfortable with the current state of the Chinese economy, and may refrain from raising borrowing costs until April. Just another reason for investors to look at Singapore instead of the Chinese renminbi (CNY).

The natural disaster in Japan has put an end to the recent rise in the price of oil. Crude oil tumbled over $4 to below $100 per barrel as Japanese refiners shut plants. This drop was dramatic, and looks to me like some traders took advantage of the natural disaster to go ahead and take profits on the higher oil prices. Currencies that were benefiting from the higher prices (Mexico, Canada, Norway, and the UK) all were down this morning as the price of oil fell.

The Norwegian krone (NOK) had its biggest decline in a week against the US dollar on the drop in the price of oil and a report which showed that inflation had slowed. Statistics Norway reported that consumer prices rose just 0.4% in February after declining in January. Lower inflation also lowers the possibility of further rate increases by the Norges bank. Mexico’s peso dropped from the strongest level versus the US dollar since 2008 on the combination of lower oil prices and the bad weekly jobs report in the US. The US is Mexico’s largest trading partner, so the poor weekly jobs report released yesterday worried investors in the Mexican peso (MXN).

The weekly jobless claims increased more than expected here in the US, and continue to hover just under 400K. Continuing claims are staying stubbornly high, suggesting the labor market will not rebound as quickly as our Fed would like. Another report released yesterday showed that the US trade deficit increased 15% in January to $46.3 billion from $40.3 billion the month before. A separate Bloomberg index indicated that consumer confidence dropped as higher gasoline prices shook consumers.

While US consumers have been scared into not spending, their elected representatives in Washington continue to believe additional spending is just what the country needs. A report released yesterday showed the US government posted the largest monthly deficit ever in February. The gap totaled $222.5 billion last month compared to a $220.0 billion shortfall in February of 2010. Fed Chairman Bernanke is worried about the size of this deficit, as he warned lawmakers last week that the deficit threatens to eventually push borrowing costs higher and curb economic growth. But congress is at an impasse on how to reduce the deficit, and therefore we simply continue to set new records of fiscal indiscipline. Not good for the future of the US!!

And finally, Chuck sent me the following notes yesterday, and they play right into the fact that the US set another monthly deficit record:

A reader sent me this story that I would like to share… “PIMCO’s Total Return Fund, the world’s biggest bond fund, has dumped all US government-related securities, including Treasuries and agency debt, a source familiar with the fund’s holdings said on Wednesday. In January, Pacific Investment Management Co.’s $236.9 billion Total Return fund slashed its US government-related debt holdings to the lowest level in at least two years and increased cash and debt holdings from other developed nations.”

Now… Doesn’t this tell us all that I’ve has been on top of the game here with regards to the Treasury Bubble, and how no one should be looking to own them? Wait till you hear what China has been doing! That’s coming, and Chris will be sure to fill you in, but, the reports I’m getting from the ground is that China is blowing out of Treasuries as if they don’t want to be the last country at the “exit door”…

I’m so scared right now… Scared for our country… Every night, I say a prayer for our country, and this is what I’m thinking of when I do so… We’re going to become a country of QE, and incestuous bond buying…printing of money…and debasing the currency… Please, someone wake me from this nightmare! And it’s not just Treasuries I wouldn’t touch with someone else’s ten-foot pole… Check this out from CNBC… “Massachusetts mayors are warning state lawmakers that without dramatic changes to the way, municipalities provide health care to their public workers, cities and towns will face dire fiscal straits for the foreseeable future, threatening core local services from police to road repairs.” The hits just keep coming for a country that wants to keep increasing its deficit spending, folks… OK, that’s enough bad news for someone that’s about to board a plane for Spring Training… Bye!

Recap… The earthquake (and tsunami) that hit Japan has rallied the yen and dropped the price of oil. Singapore will likely let their currency run up to combat inflation, and data out of China suggests there is more inflation on the way. Oil tumbled, bringing down the value of the Mexican peso and Norwegian krone. Data released yesterday show the economic recovery in the US is stumbling, and Chuck shared his thoughts from Cardinal’s spring training.

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